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Arguments Against.-(1) The proposed change would complicate bookkeeping and accounting records which are kept by farmers. Farmers forced to comply with the new provision would have their operational costs increased because of the outside professional help which they would have to retain.

(2) It would also discourage the flow of risk capital to rural areas. Generally, in line with this argument is the statement that objectives (improved livestock strains, crop experimentation, etc.) of the U.S. Department of Agriculture are being accomplished less expensively than the Government could do it itself.

(3) The limitations provided by this provision are too high, with the result that the provision will have little, if any, application in the case of many persons using the farm loss provisions as tax shelters.

(4) This provision would have relatively little effect on the hobby loss farmer, since this type of farmer generally would realize fewer gains on farm property that would bring the recapture rules into operation.

2. Depreciation Recapture

Present law. Present law provides that when a taxpayer sells personal property used in a business, there is a recapture of the depreciation claimed on the property. In other words, the gain on the sale of the property is treated as ordinary income, rather than capital gain, to the extent of the depreciation previously claimed. These rules do not apply, however, to livestock.

Problem.-The effect of the exclusion of livestock from the depreciation recapture rule is to allow a taxpayer to convert ordinary income into capital gain with substantial tax savings. This occurs because the depreciation is deducted currently from ordinary income taxed at the regular rates, but the gain on the sale of the livestock is taxed only at the lower capital gains rates.

House solution. The bill eliminates the exception for livestock from the depreciation recapture rules. Thus, gain on the sale of livestock will be treated as ordinary income, rather than as capital gain, to the extent of the previous depreciation deductions.

This provision applies to years after 1969, but only to the extent of the depreciation taken after 1969.

Arguments For.-(1) This provision is favored because it eliminates the present disparity of treatment, as far as depreciation recapture is concerned, between livestock and other types of property used in a business.

(2) Taxpayers should not be able to use the present depreciation deduction rules for livestock to convert income taxed at ordinary rates into income taxed at capital gains rates.

Arguments Against.-(1) Present tax laws should not be made more stringent against the farm industry at a time when it is undergoing severe economic problems.

(2) An extension of the complicated depreciation recapture rules to the farm industry runs counter to the established position of the Federal government since 1916 to provide simple tax rules for farmers.

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3. Holding Period for Livestock

Present law. Present law allows gain on the sale of livestock held for draft, breeding, or dairy purposes to be treated as a capital gain, if the animal has been held by the taxpayer for one year or more.

Problem.-A one-year holding period allows taxpayers to make short-term, tax-motivated investments in livestock. For example, a taxpayer can go into the livestock business to build up a breeding herd over a short period of time, currently deduct the expenses of raising the animals against his other income which is taxed in the high bracket, and then sell the entire herd at the lower capital gains rates.

House solution.-The bill extends the required holding period for livestock. Livestock will not qualify under the bill for capital gains treatment, unless the animal has been held by the taxpayer for at least one year after it normally would have been used for draft, breeding, or dairy purposes. The present one-year rule, in effect, still applies where an animal is purchased after it has reached the qualifying age.

The bill also extends this holding period requirement to livestock held for sporting purposes, such as horse racing.

This provision applies to livestock acquired after 1969.

Arguments For. (1) The holding period for livestock, in order to qualify for the capital gain rate, should be increased because the present period is not long enough to resolve the question of whether the taxpayer is truly holding the animal for draft, breeding, or dairy purposes or whether he is holding it for sale in the ordinary course of business. The intentions of the taxpayer would be more clear if the taxpayer is required to hold the animal for at least one year after the animal has reached the age when it would normally have first been used for draft, breeding or dairy purposes.

(2) The bill correctly reserves capital gain classification until the taxpayer has clearly begun to hold such animals as capital assets.

(3) This provision is favored on the grounds that by extending the required holding period for livestock, it will lessen the attractiveness of short-term, tax-motivated investments in livestock.

Arguments Against.-(1) Present tax rules should not be made more stringent against the farm industry at a time when it is undergoing severe economic problems.

(2) Under present law the holding period for farm animals is one year, or twice the amount of the holding period required for other types of capital assets (six months). Although other provisions of the bill would increase the general holding period for capital assets to one year, this provision would discriminate against many raised farm animals by increasing the holding period for them, in some cases, to periods in excess of three years (three times the general period).

(3) Questions are raised as to whether the holding period provided by the bill is, in fact, sufficiently long to significantly decrease the present tax advantages of livestock operations (i.e., whether it is appreciably longer than the period for which a tax-motivated investor otherwise would hold livestock).

4. Hobby Losses

Present law. Present law contains a so-called hobby loss provision which limits to $50,000 per year the amount of losses from a "business” carried on by an individual that he can use to offset his other income.

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This limitation only applies, however, if the losses from the business exceed $50,000 a year for at least five consecutive years. Moreover, certain specially treated deductions are disregarded in computing the size of the loss for this purpose.

Problem. This hobby loss provision generally has been of limited application because it usually is possible to break the required string of five loss years. In addition, where the provision has applied to disallow the deduction of a loss, the taxpayer has been faced in one year with a combined additional tax attributable to a five-year period.

House solution.-The bill replaces the present hobby loss provision with a rule which disallows the deduction of losses from an activity carried on by the taxpayer where the activity is not carried on with a reasonable expectation of profit. An activity would be presumed to have been carried on without this expectation of profit where the losses from the activity were greater than $25,000 in three out of five vears. This provision applies to years beginning after 1969.

Arguments For. (1) This provision will provide a more effective and reasonable basis than does present law for distinguishing between situations involving a business activity carried on for profit and situations where taxpayers are merely attempting to utilize losses from an operation to offset other income.

(2) The hobby loss provision presently in the tax law has been of very limited application because taxpayers have been able to rearrange their income and deductions to avoid the 5-year requirement of the present law.

(3) Some court decisions have adopted procedural rules in the farming cases which have made it difficult to show that the loss which the taxpayer has incurred was the result of a "hobby" rather than the result of legitimate business activity.

Arguments Against.-(1) The bill fails to recognize that farming generally is a risky operation and that substantial losses are frequently incurred in early years.

(2) The discouragement of risk capital in this industry would impair animal husbandry, and the development of new and better crop strains and farming techniques.

(3) By restricting the application of the presumption that an activity is not carried on for profit to cases where the loss from the activity exceeds $25,000, the effectiveness of the provision in dealing with hobby loss situations may be unduly limited.

(4) This provision will result in farmers who experience losses (e.g., because of crop failures) being harassed by revenue agents seeking to apply this provision.

E. LIMITATION ON DEDUCTION OF INTEREST

Present law.-Present law allows individual taxpayers an itemized deduction, without limitation, for all interest paid or accrued during the taxable year.

Problem. The present deduction for interest allows taxpayers to voluntarily incur a substantial interest expense on funds borrowed to purchase growth stocks (or other investments initially producing low income) and to then use the interest deduction to shelter other income from taxation. Where a taxpayer's investment produces little or no

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current income, the effect of allowing a current deduction for interest on funds used to make the investment is to allow the interest deduction to offset other ordinary income while the income finally obtained from the investments results in capital gains.

The principal reason why the 154 high-income nontaxable tax returns for 1966 paid no tax was the deduction allowed for "other interest" (that is, interest other than that on a home mortgage and other than interest incurred in connection with a business). In many of these cases, the interest deduction was substantially greater than the investment income and, thus, was used to shelter other income from taxation. House solution.-The bill limits the deduction allowed individuals for interest on funds borrowed for investment purposes. The limitation does not apply to interest incurred in a trade or business. Under the limitation, a taxpayer's deduction for investment interest would be limited to the amount of his net investment income (dividends, interest, rents, etc.), plus the amount of his long-term capital gains, plus $25,000.

Investment interest in excess of $25,000 would first offset net investment income and then would offset long-term capital gain income (long-term gain offset in this manner would not be taken into account in computing the 50 percent capital gains deduction).

In the case of partnerships, these limitations apply at both the partnership and the partner levels.

A carryover for disallowed interest would be allowed under which the disallowed interest could be used to offset investment income (and capital gains) in subsequent years. The basic limitation, however, would be applicable in the subsequent years.

This provision applies to vears beginning after 1969.

Arguments For. (1) This provision would limit the use of the interest deduction in connection with funds borrowed for investment purpose as a means of offsetting noninvestment income, such as a salary. In other words, a taxpayer could not voluntarily incur a substantial interest expense in connection with what is initially a low income producing investment which eventually may result in capital gains and at the same time use the interest deduction to reduce his other taxable income.

(2) Interest on investment borrowing is a controllable expense as it is usually not necessary for a taxpayer to borrow substantial amounts for investment purposes and to incur the interest expense in connection with that borrowing. Accordingly, it is appropriate to place a limitation on the deduction for investment interest, matching the limitation on the deduction for controllable charitable contributions.

(3) A taxpayer who incurs current interest expense, substantially in excess of his current investment income, is interested not only in obtaining the resulting mismatching of income and the expense of earnng that income but also in deducting the expense from ordinary inome while realizing the income as a tax-favored capital gain.

(4) Examination of the tax returns, described by former Secretary of the Treasury, Joseph W. Barr, as reporting no income tax liability for many wealthy individuals for 1966, revealed that interest deductions were a principal contributing factor to their tax avoidance.

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Arguments Against.-(1) The provision interferes with the longstanding principle behind the cash receipts and disbursements method of accounting that expenses are deducted when they are paid and income is taxed when it is received.

(2) Additional tax deductible record-keeping costs will be incurred to comply with this change.

(3) This limitation could adversely affect the stock or real estate markets where borrowed funds presently play an appreciable role. Additionally there are difficulties in distinguishing between investment interest and business interest which this provision may not adequately deal with. An example of this is the case where the taxpayer purchases 100 percent of the stock of a corporation. Although the limitation would appear to apply to this situation, it is questionable whether the purchase of the stock is made for investment purposes rather than for business purposes.

(4) This provision is unnecessarily harsh on legitimate investment transactions where good investment considerations, rather than tax considerations, are motivating factors.

F. MOVING EXPENSES

Present law. A deduction from gross income is allowed for certain moving expenses related to job-relocation or moving to a first job. The deductible expenses are those of transporting the taxpayer, members of his household and their belongings from the old residence to the new residence, including meals and lodging en route.

Two conditions must be satisfied for a deduction to be available. First, the taxpayer's new principal place of work must be located at least 20 miles farther from his former residence than his former principal place of work (or, if the taxpayer had no former place of work, then at least 20 miles from his former residence). Second, the taxpayer must be employed full time during at least 39 weeks of the 52 weeks immediately following his arrival at the new principal place of work. Generally, the courts have held that reimbursements for moving expenses other than those which may be deducted are includible in gross income.

Problem.-Job-related moves often entail considerable expense in addition to the direct costs of moving the taxpayer, his family, and personal effects to the new job location. These additional expenses include certain costs of selling and purchasing residences, househunting trips to the new job location, and temporary living expenses at the new location while permanent housing is obtained.

Moreover, the 20-mile test allows a taxpayer a moving expense deduction even where the move may merely be from one suburb of a locality to another, and the 39-week test denies the deduction where a taxpayer is prevented from satisfying the test by circumstances beyond his control.

House solution.-The bill extends the present moving expense deduction to also cover three additional types of job-related moving expenses: